Question

Latvia and Estonia are two countries. Assume that currently there is no trade between them. Each country has 100 units of labor. Latvia produces fish, at a cost of 1 unit of labor per fish, and grain, at a cost of 2 units of labor per bushel. Estonia produces fish at a cost of 2 units of labor per fish, and grain at a cost of 3 units of labor per bushel. Both countries consume both fish and grain. a. True or False, the countries can both benefit if they can trade with each other

Answer 1

Answer: True

Explanation:

Opportunity costs for Latvia:

Opportunity cost of producing fish = 1/2 = 0.5 bushels of grain

Opportunity cost of producing grain = 2/1 = 2 fish

Opportunity costs for Estonia:

Opportunity cost of producing fish = 2/3 = 0.67 bushels of grain

Opportunity cost of producing grain = 3/2 = 1.5 fish

Latvia has a lower opportunity cost in the production of fish while Estonia has a lower opportunity cost in the production of grain. Competitive advantage refers to having a lower opportunity cost in the production of a good.

Both countries can therefore gain from trade if they traded in goods they have a competitive advantage in.

Latvia would gain if they traded fish for grain and Estonia would gain if they did the reverse.